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Prospect Capital Corporation Earnings: Some Ups, Some Downs

Prospect Capital's fiscal second quarter revealed substantial movements in asset marks, but net investment income covered its new dividend.

Prospect Capital Corporation(NASDAQ:PSEC) reported earnings after the bell on Feb. 4. The company announced $0.26 per share in net investment income, which would cover its new dividend of $0.0833 per month, per share, which will be paid for the first time in March.

Net asset value declined once again, however. The company reported net asset value of $10.35 per share, down $0.12 per share from $10.47 last quarter. Roughly $0.07 of the decline stems from the current overpayment of dividends in excess of its earnings -- dividends were paid out at the old rate of roughly $0.11 per month last quarter.

The remainder of the decline stems from a combination of capital losses, and the sale of shares under net asset value. From Nov. 17 to Dec. 3, the company sold 5.4 million shares at an average price of $9.65 per share, not including shares issued as part of its dividend reinvestment program. (The company announced in a Dec. 8 press release that it will suspend its at-the-market sales.)

Cleaning out the zombiesProspect Capital has carried a number of "zombie" portfolio companies on its balance sheet for quite some time. These are portfolio companies that have been marked down to a substantial discount to their original cost, sometimes to the order of 90% or more.

In the second quarter, Prospect Capital started cleaning up its poor performers -- companies it owns that are unlikely to recover, given their carrying values. In all, it realized losses on eight portfolio companies, which tallied to roughly $96.4 million in realized losses. These losses had already largely been accounted for as unrealized losses in prior quarters.

Its CLO equity investments sold during the quarter added another $15.6 million in total realized losses. Of course, some investments were also sold at a gain -- it realized about $2 million in gains from various sources.

Movers and shakersFirst Tower appears yet again in the list of "modified" investments. Prospect Capital juiced the rate of interest on its borrowings from 10% plus 7% paid-in-kind interest to 10% plus 12% paid-in-kind. At the same time, it marked up the fair value of its equity pretty substantially.

I'm continuously amused at how the yield on First Tower debt moves so frequently. In less than one year, it's gone from 20% in cash, to 10% in cash and 7% PIK, to 10% in cash plus 12% PIK.

Nevertheless, First Tower, along with Harbortouch (two of its largest portfolio companies) received pretty large write-ups in their equity values. These will invariably be points of discussion for today's conference call.

Prospect Capital also revealed that 4.5% of its portfolio was invested in pure-play energy companies, down from 5.1% last quarter.

One portfolio company that was the subject of an article on Prospect's energy exposure, United States Environmental Services LLC, may be in more trouble than originally thought. Curiously, it's an accruing asset, but this quarter, Prospect began charging it 2% "default" interest on its debt investments with a cost basis of $59.55 million. It was marked down by $2 million more this quarter.

In addition, other significant changes include a markdown on an investment in Edmentum and Empire Today, which were marked down from $50 million and $15.7 million to $43.1 million and $13.85 million, respectively.

With so many fluctuations in marks this quarter, judgment is probably best reserved until after the conference call, on which the details surrounding its many moving parts can be fleshed out.

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